Looking Back & Ahead

This is gold over the last 3 days. I’m including the chart because it feels like today’s price action captures what it’s been like to be a gold investor so far this summer.

OK, so perhaps that’s a touch dramatic. Gold hasn’t always given up its gains within a few hours. But it hasn’t exactly done a great job of holding onto gains either.

This chart shows gold over the last year. No one reading this letter needs to be reminded of the long slow slide from August 2020 through March 2021, though this chart does remind that there were moments in that period that gave us hope…for a little while.

Of course, charts are all about context. If I showed only the last six months, gold would appear bullish. Certainly, the gains from March through May were lovely, even if June gave half of the gained ground back. Now that it’s over, we can see that July was a more stable month of sideways-to-up action.

Works for me, especially because August through October are the best months of the year for the yellow metal. Entering that period from a stable and slightly positive footing helps.

I’m speaking in broad strokes because I will admit that I paid only the slightest bit of attention to the price of gold while on vacation. I watched enough to know it hadn’t spiked or fallen off a cliff. And it was nice to not analyze daily moves because these days the price of gold depends primarily on the nuances of Fed Reserve Chair Powell’s comments, as the market scours each word for dove-versus-hawk sentiment and then reacts based on how that matches up to expectations (not, I might mention, based on what macroeconomic data might actually mean for growth, inflation or deflation, and interest rates).

If you sense a touch of fatigue in my comments there: it’s true. It’s hard to continue figuring out what the market wants (GDP and jobs growth but no inflation and certainly no talk of tapering or rate hikes) and how that impossible set of desires jives with the latest data or FOMC comments.

So in coming back from a break, I see:

• A gold price chart that was stable to up through the usually quiet month of July (good – no surprises there)
• A copper price that was just about the same

• Bond yields have been dropping. Below is a three-month chart of the US 10-Year Treasury yield.

• Remember, real rates are the most important factor for gold. Gold gains when real interest rates are falling and especially when they are negative and falling. We calculate real interest rates by correcting yields for inflation. The 10-Year Breakeven Rate is a forecast of average inflation over the next ten years, so it’s the best metric to use when calculating the real 10-year yield. As you’d expect from all the inflation talk, the 10-Year Breakeven Rate ramped up November through May and has basically held high and steady since.

• So yields have been dropping and inflation has been holding high. Doesn’t take much math to realize that means real yields have been falling. Here is the 10-Year Yield adjusted for inflation. Real yields dropped dramatically from May through August 2020, which is what drove gold up from US$1,700 per oz. above US$2,000 per oz. then they bottomed and bounced around, a lack of clear direction leaving investors to parse Powell’s words endlessly. Over the last month, though, real yields have once again established a clear direction: negative and down. The real yield on the US 10 Year is now lower than it was a year ago when gold was topping out above US$2,000.

• So the big question is: WHY isn’t gold trading better??? The chart below, from Sprott, shows how closely gold usually tracks real rates (inverted) and how the two have diverged of late.

I blame the endless inflation debate. Is it transient or will it persist? I think traders are hesitating on gold in case inflation does ease (which it will). But that is frustratingly short-term thinking because, though less inflation means slightly less negative real rates, it also takes away almost all reason for the Fed to raise rates, and keeping rates essentially at zero means real rates will stay negative!

Let me return to the first chart for a moment. Gold popped this morning because the ADP jobs numbers came out. ADP numbers are reliably unreliable but they always come out two days before the non-farm payroll numbers. And the July jobs number is the data point that the market is watching this week.

Why? Because the one thing from Chair Powell’s last testimony that stuck for me was that he basically doesn’t care about inflation. Of course, he actually does, but tempering high inflation is about as easy as it gets for a central banker. Raise interest rates and watch. If needed, repeat. It’s not nice for the economy but it always works.

So inflation doesn’t keep Powell up at night. What does keep him awake are jobs. He basically said that he does not want to raise rates until unemployment rates improve markedly. The jobs market is a weird one these days, with reports across the continent and across industries of a lack of workers happening alongside high unemployment and with COVID benefits overs.

Powell can’t send the unemployed to be retrained or move people from areas where jobs lack to places in need of workers. All he can do is keep rates low, which lets businesses spend on employees and growth rather than on debt and keep other business supports going, which range from corporate bond purchases to COVID loan forgiveness programs. His latest comments suggest he will keep doing what he can until more people are employed.

We’ll see how that went in July when the jobs report comes out on Friday. The consensus is that it will be similar to last month’s 800,000 job gain and that there will be little change in the other metrics (wages, hours worked, and the unemployment rate). If that’s how it happens, there will likely be little response. But in today’s world, where traders twist and wring out every bit of data for any reason it might make the Fed more dovish or hawkish, a beat would be bad for gold and a miss good.

Why? Because more jobs than expected means strong growth, which creates hawk pressure. Fewer jobs mean weak growth, which supports ongoing accommodation.

Today’s ADP report was a preview – and it was a big miss. The private sector only added 330,000 jobs versus an estimate of 653,000. The ADP report is notoriously unreliable, with significant revisions almost always layered on a month later, but it does usually end up on the same side of forecasts as the official non-farms number. In other words, the ADP report suggests we are going to see the July job count disappoint on Friday.

And that would be good for gold. Even this ADP count was good for gold, if only for a few hours. I think a similar miss from the official non-farm number would have a similar impact but with longevity.

I would welcome such a move with open arms. It could (1) kick of gold’s strong season, (2) remind traders that gold is not only an inflation hedge but a reliable gainer when real rates are negative, and (3) emphasize that gold miners, who just delivered strong earnings almost across the board with dividend boosts for many, have more upside ahead.

And I guess the market needs yet more evidence of strength and ongoing upside from miners, even though they are among the most financially robust stocks out there (lowest debts, highest free cash flows, strongest dividend payouts). I’ve shown this strength in many different graphs over the last year.

Yet even though miners are brimming with free cash and handing out ever bigger dividends, precious metal miners have had a dismal few months. In June and July gold dropped 6% and silver lost 11% but gold and silver equities, as judged by the GDX and GDXJ indices, lost far more.

That’s the leverage that we love on the way up exerting itself on the way down as well, of course, but it also underlines that flood of buy-and-hold generalist investors that fuel a real gold bull market still has not arrived.

Now, with strong financials reported across the space and good odds (I think) of higher gold and silver prices in the next few months (because of seasonality and real rate realities), I think there’s a good chance that miners, developers, and even explorers re-rate to the upside through the fall.